Forex Basic Concepts

In the Forex Market the speculators are actually negotiating the relative purchase power between currencies, that is, the relative value of one currency against another. This is known as exchange rate or better known as Foreign Exchange.

Forex parities consist of a relative ratio between currencies and is also organized in order. An example of such parity consists of the X currency against the Y currency, X / Y, and it called that X is the base currency of the parity, and Y is the traded currency of the parity.

At the moment you start trading, such position in the currency pair you are speculating, you are actually performing two transactions simultaneously, one is buying a currency and the other is selling the currency instantly. The scenario is as followed:

  • If the transaction is a long position in the parity, one order is to buy the currency base and simultaneously sell the other currency.
  • If the transaction is a short position in the parity, one order is to sell the currency base and simultaneously buy the other currency.

This basic concept is essential to understand the mechanics of the Forex Market and the origins of exchange rate trends, and is the basic principles of investment in the Forex Market.

Rollover is a must paid fee by holding an open position for more than one business day. This fee / income is derived from the differential of short term interest rates involved in the transaction. Rollover is generally daily settled and debited / paid from the balance of your trading Forex Account. The Formula for calculating the rollover is as followed:

Daily rollover=(Interest rate(buy)−interest rate (sell))/360∗position size

Rollover is calculated and executed automatically by the broker.

The interest rates differential between countries is known as Carry Trade where one is to buy currencies whose interest rates are commonly high and sale the currencies with low interest rates, in order to achieve an income derived from the net interest rate in favor.

Lot in the Forex Market is the representation of the monetary amounts traded. Those monetary amounts are always represented in the base currency.

See below the standardization of Lot

Standard lot 100,000.00 Mini lot 10,000.00 Micro lot 1,000.00

Trading the Forex Market is carried out through a Margin. The Forex is the least volatile compared to 4 major financial Markets such as, Equities, Commodities and Fixed Income since they are generally very volatile. Through a Margin, Brokers are able to finance their clients trading speculations and optimize their trading results.

The initial Margin is the percentage the broker demands as collateral so the trader can carry out any transaction. This Margin is taken from the nominal size of the transaction. Such percentage is used by the broker and base on the volatility is calculated daily or weekly in order to find out the required margin. The following chart shows the % of initial margin required by brokers totalling the right leverage for each account:

Margin% Lev Broker 1% 100 0.50% 200 0.25% 400

Equity is the net amount the trader have in their trading account, after adding/subtracting the unrealized gain/loss of all open positions as a floating balance. The Equity is calculated base on the fluctuation of each open position.

From the initial Margin and the Equity of the account, you can calculate the Free Margin and is calculated as followed:

FREE MARGIN = 𝐸𝑄𝑈𝐼𝑇𝑌 – 𝑀𝐴𝑅𝐺IN

This Free Margin number is what the broker takes into consideration in order to execute the so called: Margin Call. A Margin Call is the execution of all open positions since the account is literally without any collateral left due to all losses carried out by the transactions.

Leverage in financial terms is a form of borrowing money for trading purposes and the total leverage of the account corresponds to the ratio between total exposure and the balance.

The exposure of any Account is the sum of all active transactions and the total of their sizes. The size of each transaction is called a lot which it can be divided by decimals but the context of the addition, it adds up to a lot. The higher the exposure of the account, the higher the leverage, therefore there is a greater risk of suffering a Margin Call. An example in a portfolio investment, the leverage ratio is about 6 to 8 times the balance of the account .

“Volatility represent risk, but also opportunity.”

The Volatility of a financial asset corresponds to the fluctuation/ amplitude of any price movements over a given period of time. This Price Variable is important to limit in an adequate time frame.

Volatility represent risk, but also opportunity. Given the fact that profits come from any trading activity and if there is absolutely no price movement, there are no gains. Any Gains or Losses in the Account are the result from any volatility.

Exist different types of Volatilities:

  • Historical Volatility: It’s calculated from past data.
  • Dynamic Volatility: Economic fundamentals with the ability of predictive value of volatility.
  • Implied Volatility: Regular Market Volatility, arises from the volume traded from different market participants.

In summary to understand what is volatility, please see the following:

  • Price trading behavior
  • Trading opportunities
  • Stop losses orders
  • Take profit orders

Volatility trading scenarios:

  • No price direction: No Volatility, Narrow Ranges, No Movement
  • No price direction volatility: Broad ranges, generally categorized by sudden movements to either direction, but no definite trend.
  • DIrection – no Volatility: definite directional move but stabilized
  • Directional – Volatility: Vertical directional movements, very unusual and generally derived from a specific catalyst.

Traders objectives in regards to volatility:

  • Identify the reason of such volatility in order to trade it.
  • Find directional trading opportunities.
  • Trade along with catalyst volatility.

Feel free to contact Andres Salazar to learn more about Forex and trading concepts.
Why choosing a broker committed to Technology is a good Signal

Andres Salazar
Sales VP LATAM
asalazar@tvmarkets.com